EM and Reps & Warranties: Do they survive?

Question

So I just had a deal fall apart over Ernest Money (EM) and Reps and Warranties (R&W).

As a Canadian looking to invest for the first time in the US, I can't help but wonder if the standard practices are that different and this is just part of the learning curve. On the other hand, the seller could just be a nut bar. Here is (was?) the situation:

The property is an ~50K sq ft commercial office building in TX. We got the LOI done and started working on the sales agreement. Minor issues aside, the Seller and his lawyer were adamant that no R&W survive closure. Even such simple declarations such as if the Seller was a 'Foreign National'.

The Seller claimed that this was standard language in CA, AZ, TX and that this was boilerplate language. Our lawyer says explicative! explicative! ;). Our lawyer (based in FL but has done many deals in TX) has never done a deal where R&W do not survive. Nor have I ever seen them not surviving here in Canada.

Another deal breaker was with respect to the EM. Our position was that none get released until after closing. Their position was that it gets released as soon as the inspection period is completes. Now I have seen deals with non-refundable EM in rare cases but really? Odd things do happen; you go through DD (Reports, commitment fees, appraisals, etc.) and move to closing. If the Seller simply does not show up, not only are you out the DD costs but also the EM?

Leaving an Auction situation aside which, I think, is(?) an exception, what is standard practice in the US with respect to the survivability of R&W?

How do you view EM; as a deposit subject to performance or a Fee for the privilege of getting the DD material?

Thoughts and comments?

John Bowen · Answer

We bought a 25,000 square foot complex in Texas this year and it was very clear that nothing survived closing. It was a forclosure, handled by an asset managment company in Maryland. Working out the contract was the biggest headache. It had to be on their contract, but we did get many of the absurd conditions struck.
 As they had very little knowledge of the property I could understand their reluctance to stand behind anything regarding it.
Our EM was refundable until we finished DD or at the end a set time frame. I did have to wire the EM to their title company in DC.
 It was a rather complicated deal, but well worth it when done.

Oren K. · Answer

Joel,

Yes, I would expect them to be similar. So, do R&W survive closing?

On the EM side, I see I wasn't specific enough. The issue was not that the EM would become non-refundable. If we got through DD, presumably the deal would become what we call 'firm'.

What he wanted was that some of the EM would be released in to his hands. That was a 'NO GO'.

Your comments reflect what I would expect with EM. EM, typically, gets put down in two stages; an initial deposit to show commitment, then you go through DD and if it all passes (and you can arrange financing), it goes firm. At that point it is also common to put down a larger second deposit. All the funds get credited to the purchase on closing and if the Purchaser does not perform for whatever reason, the deposits are forfeit to the Seller. If the Seller does not perform, the funds are returned to Purchaser.

Oren

Joel Owens · Answer

When earnest money is held you never let the seller or their counsel hold it. Instead have your council hold it or the title company.

The problem with the seller or counsel is they are supposed to return the money but even if the contract says so you have to chase them down or they take forever.

When I was assembling land for a developer they always held the EM they put down so they didn't have to chase the sellers for it later even when it was due them contractually.

Joel Owens · Answer

Hi Oren,

It Is typical once due diligence is done that the earnest money becomes non-refundable.

The buyers attorney usually has a clause in there where the seller agrees to perform and go to closing in an expedient manner. If the seller does not then the buyer has an out and still retains the EM.

If you are assuming an existing loan and putting equity down there is an additional clause where you the buyer have an out if the lender doesn't approve you etc.

The LOI is completed by usually a broker like me and then when the purchase and sale comes up that is when the attorney go back and forth with multiple revisions until everyone agrees on the final draft.

Sellers can be difficult sometimes with properties. You have to take emotion out of it and remove the roadblocks to close the deal where it works for both parties.

I do triple net and multifamily nationwide. I do not mess with office as I don't specialize in it but the deal flow and provisions in contracts are similar.

Hope It helps.